Deficient demand refers to the situation
when aggregate demand (AD) is in short of aggregate supply (AS) corresponding to fullemployment in the economy.
AD < AS :
Corresponding to full employment.
Desired AD in
the economy happens to be short of its full employment level.
It
implies that desired AD does not permit production at the full employment, due
to deficient demand, equilibrium between desired AD and desired AS is struck at
a level lower than full employment in the economy, this is a situation of
underemployment equilibrium.
Deficient
demand may be caused by decrease in the value of various components of
aggregate demand
i.e.
AD = C + I + G +
(X - M)
Thus,
deficient demand may be caused by
the following factors:
1)
Decrease in the consumption expenditure by the household due to increase in the
propensity to save and reduction in propensity to consume.
2)
Decrease in private investment expenditure.
3)
Decrease in government expenditure this may be due to losses in public
enterprises. In such a situation, instead of making fresh investment, the
government may resort to disinvestment, implying a cut in AD.
4)
Decline in export, owing to lower domestic demand in rest of the world.
5)
Rise in imports, owing to lower international prices compared with domestic
prices. A rise in import implies a cut in AD as imports are negative components
of AD.
6)
An increase in tax rates leaving lesser disposable income with the people. This
leads to reduction in their capacity to spend
7)
Decrease in money supply due to reduction of credit facilities by the
commercial banks.
Below
figure illustrates the situation of deficient demand.
 |
| deficient demand |
AD: Aggregate demand at full employment
AD1: Aggregate demand
corresponding to underemployment
FC: deficient demand
OM: Full employment level of output
ON: equilibrium output owing to
underemployment
AD
is Full employment Aggregate Demand. The intersection of AD curve
with 45◦ line at F gives us the equilibrium corresponding to full
employment level of output M.
Now,
suppose aggregate demand curve shifts downwards to AD1 due to say,
decrease in government expenditure.
At
the full employment level of income, the aggregate supply is OM or FM. This is
greater than aggregate demand of CM.
The
deficient demand at the full employment income is FC
Deficient
demand = FC = AD - AD1 (FM –
CM)
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